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Committee on Financial Services

United States House of Representatives

Archive Press Releases

Committee on Banking
and Financial Services

James A. Leach, Chairman

For Immediate Release:
Wednesday, May 3, 2000

Opening Statement
Of Rep. James A. Leach
Chairman, House Banking and Financial Services Committee
Hearing on Payment of Interest of Sterile Reserves

Today the Committee meets to discuss issues related to authorizing the Federal Reserve System to pay interest on the sterile reserves that depository institutions are required to hold with the Fed. In this regard, our esteemed colleague from New York, Rep. Sue Kelly, has introduced H.R. 4209, the Bank Reserves Modernization Act of 2000, with co-sponsorship from Rep. Jack Metcalf, of Washington, who has been a longtime supporter of this concept, and Rep. Jim Maloney of Connecticut.

This proposal has been considered several times in the past by this Committee, usually in conjunction with legislation to allow banks to pay interest on business checking accounts. This year, the issues have been legislatively de-coupled and last month the House approved on a bipartisan vote H.R. 4067, the Business Checking Modernization Act.

From the banking industry’s perspective, the payment of interest on reserves appears on its face to be only fair. Banks would be allowed, like their customers, to collect interest on their savings. In addition, the Fed would be better able to manage monetary policy because disincentives for holding funds at the Fed would be reduced.

By way of background, the sole purpose for reserves, as clearly stated in the Federal Reserve Act, is as a tool for the implementation of monetary policy. The Federal Reserve Open Market Committee sets a target interest rate for the Fed funds market -- the market in which banks lend to each other. The statutory requirement to maintain reserves helps to ensure a stable, predictable demand for funds, and the Federal Reserve affects interest rates by adjusting the supply of funds available for meeting that demand through the New York Federal Reserve Bank’s open market operations.

Required reserves have been an integral part of how the Federal Reserve conducts monetary policy.

However, because of the constraint imposed on depository institutions in their ability to earn a return on assets they control, depository institutions understandably have undertaken considerable effort to find methods to reduce their reserve requirements and have thus undercut this key monetary policy tool. As a result, required reserves held at Federal Reserve banks have dropped to $6 billion, from $28 billion, in only seven years.

While many other countries do not employ reserve requirements and use different tools for implementing monetary policy, the traditional American method fits our system reasonably well.

Without this tool there could be an increase in the volatility of interbank interest rates that could affect interest rates for the public. The door could be opened to proposals to provide the Fed with other mechanisms to implement monetary policy that could lead to uncertainty in the markets, particularly during periods Congress might be grappling with the issue.

In fact, banks, credit unions and savings associations argue that the reserves they hold at Federal Reserve Banks amount to an interest-free loan to the Federal government and thus a tax. If, however, reserves were not required to be held by these depository institutions, the Federal Reserve would have less in earnings to return to the government. Authorizing the Federal Reserve to pay interest on sterile reserves thus carries a budget impact, although with the decline in reserves it would not be nearly as great as would have been the case a decade ago.

But this modest revenue loss -- less than one percent of what the Fed turns over to the Treasury each year - would be counterbalanced by the enhanced ability of the Fed to effectuate a consistent monetary policy.

The debate is then whether a policy that leads to modest revenues foregone is important for this country, its economy, its citizens and its banking system and whether, if a change in policy takes place, resources should come from the Fed’s surplus account, rather than implicitly from other programs. There are the issues this Committee will have to review.

The distinguished Ranking Member, Mr. LaFalce, is recognized for a statement.



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